Investigating risk pooling to insure against pandemics

Vol: 43 Issue: 4 | Dec 2021

COVID-19 is taking a terrible human toll, with more than 1.6 million deaths at the time of writing and more than 72 million cases worldwide.

Equally, this pandemic is severely impacting the global economy. The Asian Development Bank estimates losses of up to US$8.8 trillion — or almost 10 per cent of global gross domestic product — as a direct result of coronavirus. Additionally, as many as 242 million people worldwide could lose their jobs, with overall income reduced by US$1.2 trillion.

INSURERS SHY FROM SYSTEMIC RISK

Unlike other catastrophes such as earthquake, flood and fire, the insurance industry has long considered pandemics too systemic a risk for the insurance of economic losses, except in limited cases. However, given the unprecedented protection gap in the case of COVID-19, debate and work are taking place on many industry fronts to come up with a solution.

UK-based Pool Re CEO Julian Enoizi argues that without an existing framework for collaboration between (re)insurers and government, there was no way to prevent coronavirus from being an economic disaster.

In an article on pandemic risk pools on the Pool Re website, Enoizi quotes Marsh & McLennan Companies president and CEO Dan Glaser’s point that although governments ‘acted quickly’ to support economies during COVID-19, it was ‘all done after the fact’.

Enoizi highlights Glaser’s observation that the effects of the pandemic ‘would have been less severe with a greater level of “commitment and organisation” between the public and private sectors as regards to risk transfer, mitigation and restoring confidence’.

FORMING THE RIGHT PARTNERSHIP

Paula Jarzabkowski, Professor of Strategic Management at the City, University of London Business School and the University of Queensland Business School, has published extensively on the topic of public–private partnerships in the event of catastrophe. 

She argues a public–private partnership with a government backstop is the only way the economic losses of a pandemic might be covered affordably.

‘It would work to create a public–private or fully public sector risk pool with a view to working with the private market to distribute insurance products,’ says Jarzabkowski. 

‘Policyholders or businesses could be levied for a business interruption product and the premiums all passed into the pool, which would then build up as a pot of capital with a backstop from the government.’

She adds that we need to remember that not all pandemics will present like this one and we should ‘begin to understand what degree or type of pandemic the private market could take’. ‘A risk pool is a very good way to go about establishing an insurance product that can gradually be shared with the private market.’

RISK POOLS: A POWERFUL TOOL

Catastrophe risk pools can be a powerful tool to overcome market failures and enable risk transfer at affordable prices while contributing to higher insurance penetration among exposed population groups.

‘Equally, public–private risk pools also need to accommodate political preferences and priorities,’ says Michael Schwarz, managing director and head of Public Sector Asia Pacific at Guy Carpenter.

‘A simple example of this is the absence of full mandatory insurance in many catastrophe schemes, which, in many instances, would help increase insurance penetration.’

Several successful catastrophe risk pools have been established over the past 20 years, ranging from those covering residential homeowner risk to multi-sovereign facilities utilising parametric triggers that provide cash injections to vulnerable populations.In the United States, United Kingdom and Australia, as elsewhere, successful schemes also exist where government-backed pools share the systemic risk of terrorism with the private market, allowing capital for losses as well as investment, research and modelling incentives to understand and price the risk more effectively.

PANDEMIC POOLS IN PERSPECTIVE

While a terrorist attack might cripple part of a city or a cyberterrorism attack impact a few countries, neither are likely to affect the entire globe as we have seen with COVID-19. That puts the sheer size required for a pandemic pool into perspective.

Jarzabkowski also says multi-sovereign risk pools are unlikely to work for a pandemic. 

‘The whole point of a multi-sovereign risk pool is to share the mitigation of a commonly understood risk such as flood. Sovereignty is problematic in a pandemic. For example, the choices governments made to lock down, which led to business interruption, were political choices. 

'Those actions were not related to the peril itself but to the way governments chose to deal with the peril.’

Schwarz says the political, legal and cultural contexts vary from country to country, so catastrophe pool arrangements and features need to reflect specific boundary conditions, goals, priorities and the underlying motivation that led to their establishment.

‘There is no one-size-fits-all approach, so success needs to be assessed and seen against such factors,’ he says.

Schwarz adds that pandemic risk is ‘fundamentally different from those risks for which cat pools have been established to date’.

‘Consequently, (re)insurance as well as capital market capacity can only absorb a very small portion of the total risk,’ he says. ‘However, there is certainly room for new forms of public–private partnerships that address pandemic risk on various ends, including risk assessment, reduction and adaptation.’

PRE-EVENT FINANCING MECHANISM

Given the government backstop needed for a pandemic risk-transfer scheme to work, Schwarz says the solution is less a traditional catastrophe pool and more a ‘dedicated catastrophe funding scheme which results in a shift from ad hoc post-event responses towards a dedicated government pre-event risk-financing mechanism’.Swiss Re advocates for all types of infectious diseases and associated outbreaks (whether localised or not) to be removed from private business interruption (BI) policies and covered under private — public BI scheme policies instead.

Vincent Eck, managing director and head of Public Sector Solutions for Asia Pacific at Swiss Re, says the aim is to ensure that society is better prepared for the next pandemic. 

‘Pandemics can be both frequent and severe, no two outbreaks the same, and baseline determinants — such as social norms, the political environment, nutrition and climate — remain largely untested,’ he says. 

‘Therefore, the outcomes will be dependent on the arrangements and preparations already in place, as well as selected interventions and the timeliness of action.’

FISCAL RESILIENCE

Eck agrees that fiscal resilience in the form of pre-arranged financing is a better solution than the ad hoc support governments have so far had to devise. ‘Financial preparedness — for all types of risk — is the best solution,’ he says. 

‘This includes insurance of known and measurable risks, which builds resilience and frees up funds for governments to deal with the severe, unexpected events.’ 

Australian Reinsurance Pool Corporation (ARPC) CEO Dr Chris Wallace confirms that the state guarantees of many pooled schemes would be inadequate for the sheer scale of a pandemic.

For Wallace, governments have quite rightly focused on providing fiscal stimulus for pandemic relief measures to save jobs and businesses. He believes an effective pandemic BI response would ideally target small business policyholders who need cover the most. 

‘It would require a simple benefit that can be rapidly delivered through a parametric trigger, and it would need to be time limited to curb the financial risk to a government guarantee,’ says Wallace.

A proven terrorism pool backed by the Australian Government, ARPC is familiar with the limited appetite reinsurers have for terrorism. However, Wallace argues that it is beneficial for them to participate in retrocession reinsurance programs run by pools.

‘Such pools offer reinsurers a homogenous pool of risks and allow them to participate and limit their exposure to each country,’ he says. ‘The same could apply to pandemic risk. In a pandemic pool, I expect there would also be limited retrocession appetite.

‘However, pools enable reinsurers to choose to deploy their scarce capital to geographic regions and to limit their capacity. This limiting of capacity by size and region should enable a reinsurer to participate in a limited way in supporting future pandemic pools, which still diversifies their risk.’

AT THE HEART OF RECOVERY

Schwarz says central to the success of a pandemic risk funding scheme is awareness of what both the private and public sectors can and need to contribute.

‘While pandemic risk capacity from the private sector is clearly limited, the insurance industry can help in various ways — for instance, with respect to understanding and pricing pandemic risk and by providing an established and efficient network for cash flow management,’ he says. 

‘Governments on the other hand need to ensure legal certainty and provide enabling legislation and regulation, as well as incentive structures.’

Enoizi argues that having constructive solutions available means ‘having insurers at the heart of the recovery from the next national crisis’.

This, he writes in his blog, will require viable cover for ‘mega-tail events or the black swan situation — be it a pandemic, a systemic cyber event, a terrorist attack or liabilities associated with climate change and geopolitical turbulence’. 

For this reason, he says, ‘creating a public–private facility to backstop pandemic risk alone, significant as this would be, would only see a similarly damaging pattern play out next time a catastrophic risk manifests and a crippling protection gap is revealed’. 

‘It is not the trigger,’ he adds, ‘but the systemic consequences we must partner with the government to address.’

CREDENTIALS IN CHALLENGING TIMES

Enoizi points to the proposed expansion of his own organisation, Pool Re, into an ‘umbrella’ facility, ‘Resilience Re’, which would aim to ‘benefit from economies of scale by not only uniting existing state-supported pools but creating further pools to facilitate (re)insurers’ participation in risks for which there are currently little or no commercial market’.

Through this approach, he explains, businesses would have access to comprehensive, affordable protection against BI losses resulting from systemic risks, and (re)insurers could enjoy profit and innovation opportunities while reasserting their ‘credentials as a sector’ in challenging circumstances.

‘Meanwhile, an integrated public–private structure for managing disaster risks would allow the government to monetise its guarantees as it does for terrorism,’ says Enoizi, adding that the ‘state would be in a position to realise the full potential of the risk mitigation expertise of the insurance industry and work with it to smooth economic damage when the next disaster strikes’. 

BENEFITS OF TERRORISM POOLS

For example, ARPC in Australia, Pool Re in the UK and TRIA in the US

1. Pools have relationships with government or are often a part of government.
2. Pools have existing people, systems and processes that can be deployed in a crisis to other systematic risks.
3. Pools support the pooling of risk, bringing about community rating makes premiums unaffordable for customers.
4. Pool retrocession programs protect taxpayers and engage the private reinsurance industry in participation and capacity.
5. The pool allows for quantification of risk from a reinsurance standpoint, which means reinsurers can support-coverage in a limited nature as the amount reinsured is capped at the total size of the pool.
6. Governments are often compensated for their risk-bearing roles through the pools.

RISK POOL SUCCESS STORIES

Pooled risk schemes have already proven effective in strengthening disaster preparedness and crisis response, improving insurance literacy and affordability around the world.

CARIBBEAN

The Caribbean Catastrophe Risk Insurance Facility is a parametric hurricane and earthquake insurance pool covering more than 20 Caribbean and Central American governments. Member governments can choose how much coverage they need, up to an aggregate limit. The payouts are triggered by the intensity of the event (modelled loss triggers). This model has been successful, benefiting a number of countries and communities with payouts:

2010 — US$24.92m to Haiti, Barbados, Saint Lucia, Anguilla, and St Vincent and the Grenadines

2016 — US$1.1m and US$500,000 to Nicaragua for Hurricane Otto and an earthquake

2017 — US$48.96m to 13 Caribbean countries for Hurricanes Harvey, Irma and Maria

TAIWAN + TURKEY

The 1999 earthquakes in Taiwan and Turkey resulted in significant losses for private homeowners, among others. Through the subsequent establishment of the Taiwan Residential Earthquake Insurance Fund and the Turkish Catastrophe Insurance Pool, the governments in Taiwan and Turkey have helped increase earthquake insurance penetration significantly in both countries, with exposed homeowners having access to at least some basic protection.

NEW ZEALAND

The Earthquake Commission (EQC) in New Zealand is an insurance pool that protects the first layer of all insured private residential buildings and land against named perils. A flat rate levy is imposed on all households that purchase a homeowner insurance policy to fund EQC’s National Disaster Fund. 

The scheme is government-owned and has been in operation since 1945. EQC levies make up part of home and contents insurance premiums. 

As the levy is flat across all policies, the better risks cross-subsidise the poor risks. It provides multi-peril coverage for homes — for example, earthquake, natural landslip, volcanic eruption, hydrothermal activity and tsunami.

A PUBLIC-PRIVATE APPROACH IN THE US

Property and casualty insurance giant Chubb is pushing for a public-private partnership to address future pandemics in the United States.

Under the proposal, the US Government would offer up to US$750 billion in coverage for small businesses with up with 500 employees. Of that, the industry would pay for 6 per cent of claims, or up to US$15 billion, during the program’s first year, growing annually to 12 per cent by year 20. COVID-19 would be excluded.

The proposal also includes a program for businesses with more than 500 employees, which would be voluntary for insurers and provide a total of up to US$400 billion in coverage through a government reinsurance entity.

Insurers would share up to US$15 billion during the program’s first year, rising to US$40 billion during its 10th year. Payouts to businesses would be limited to US$50 million per policy.

Also currently being discussed in the US is the Pandemic Risk Insurance Act of 2020 [PRIA].

PRIA comprises the establishment of a government-administrated insurance backstop that would pay for business interruption (BI) claims related to a pandemic. Once the Pandemic Risk Reinsurance Program is established, participating insurance companies will annually pay deductibles to fund the program.

The legislation also provides for the treatment of existing BI insurance policies resulting from the COVID-19 pandemic.